Exercising ownership rights in state owned enterprise groups : what China can learn from international experience

Exercising Ownership Rights in State Owned Enterprise Groups: What China Can Learn from International Experience William Mako and Chunlin Zhang December 31, 2002 An enterprise group in China is defined by government regulation as "a combination of legally independent enterprises" made up of a parent company, subsidiary companies in which the parent has majority ownership, member companies in which the parent has minority ownership, and other member enterprises or institutions.1 At the end of 2000, there were 6027 registered enterprise groups2, in which 2655 are considered as "large enterprise groups", defined as those whose sales revenue and total assets exceed RMB500 million. In 2000, these large enterprise groups accounted for 11% of China's urban employment, 22% of exports, and 57% of assets in the industrial sector3 . The authorities expect enterprise groups to play an increasingly critical role in development of the Chinese economy in a post-WTO environment. The Communist Party Central Committee "4th Plenum" on SOE reform in 1999 called for "fostering strong and competitive large enterprises and groups" so that they can become "the pillars of national economy and major forces of China in participating in international competition". The Tenth Five-Year Plan approved by the National People's Congress (NPC) in 2001 also requires "development of a number of large companies and enterprise groups with well- known brand names, independent intellectual property rights, clearly-defined and strong core businesses". State ownership dominates large enterprise groups in China. Of the 2655 large enterprise groups, the state is majority owner of the parent of 1605. These tend to be the largest of the large. State-majority large enterprise groups account for 92% of the assets and 87% of sales for all large enterprise groups. While the state is moving to "withdraw" from non-strategic enterprises, significant state ownership of enterprise groups is likely to continue in the short to medium term. At the end of 2000, China still had over 190,000 state-owned enterprises. For the foreseeable future, deepening reforms in large state owned enterprise groups, for example, in the fronts of internal control and corporate governance, will depends critically on the way the state exercises its ownership rights, i.e., the reform of state assets management system. 1A legally independent enterprise in China can be a company registered under the Company Law, or a state owned enterprise registered under the All People Owned Enterprise Law (enacted in 1988), or other enterprises that are independent in terms of responsibility for accounting and debt re-payment, such as collectively owned enterprises, joint ventures, partnerships, and sole proprietorships. 2State Administration for Industry and Commerce: China Industrial and Commerce Administration Yearbook, 2001. 3NBS: China's Large Enterprises Groups in 2000, and China Statistical Yearbook 2001. 1  This note addresses the question of how the Chinese state could exercise its ownership rights in large state owned enterprises in a more effective way, by drawing lessons from relevant international experiences. Since large state owned enterprise groups share the same institutional framework of state assets management system with other SOEs, the policy recommendations of this note may have broader applicability. The rest of this note is organized as the follows. In section I, the institutional challenges of exercising state ownership rights in SOEs in China and past efforts of reform are highlighted. Section II presents relevant international experiences. Key policy recommendations appear in section III. 2  I. The Institutional Challenges China's SOE Sector: an Overview In 2000, China's 190,508 non-financial state owned enterprises (SOEs) produced roughly 1/3 of its GDP. Their balance sheets recorded over RMB16 trillion assets, with slightly less than RMB10 trillion liabilities. The total accounting value of state owner's equities was reported as RMB5.8 trillion by the Ministry of Finance. 49% of the SOEs were profitable, and reported a total profit of RMB 0.47 trillion in 2000, while 51% of them made a total loss of RMB 0.18 trillion, leaving a net profit of RMB 0.28 trillion to the state, which is 1.5 times higher than 1999 and 1.2 times higher than 1995. 52.7 million people were employed by these SOEs, accounting for 7.4% of total employment and 25% of urban employment. SOEs are classified as of large, medium or small size. In 1999, 72% of the state owner's equities was found in 9000 large SOEs, while 31000 medium and 177000 small ones shared the rest (12% and 16%, respectively). The Pre-Reform Regime Given the size and diversity of the SOE sector, the Chinese state has developed a system of division of labor in exercising ownership rights in SOEs. First, ownership rights are exercised by every level of government, from the national government to provincial, municipal and county governments. Second, ownership rights are shared by a wide range of government and Party agencies. This division of labor is reflected by the concept of "subordinate relation (li shu guang xi)". In the pre-reform regime, a SOE being "subordinated (li shu yu)" or "supervised (zhu guan)" by a particular level of government would typically mean that the government and party committee at this level exercised the following rights: